Growth Stabilizing

This note was originally published
at 8am on January 03, 2013 for Hedgeye subscribers.

“It is gone forever.”

-Jeremy Grantham

That’s what legendary investor, Jeremy Grantham, started off his Quarterly Letter with in November. It was titled “On the Road to Zero Growth” and was published right around the time that the Barron’s cover read “Are We Headed For A Recession” (November 12, 2012).

I have a tremendous amount of respect for Grantham’s long-term TAIL risk work, but that doesn’t mean I always agree with him; especially on timing. For the last six weeks, our Global Growth Model has explicitly disagreed with A) a global recession and/or B) anything that remotely resembles 1% US growth, never mind 0%.

Since the mid-December cover of The Economist was titled “A Rough Guide To Hell”, I think being relatively bullish on stocks (and bearish on both Bonds and Gold) here is still the contrarian call to make. I don’t make calls on forever.

Back to the Global Macro Grind…

I’ll come back to the multi-duration, multi-factor, risk management support for the aforementioned research view in a few minutes. First, let’s just take a moment to respect what yesterday was – easily the most bullish 1-day move for growth expectations in at least a year.

After holding its 1419 line of TREND support, the SP500 ripped to within 0.8% of its September 2012 intraday high

The Russell 2000 closed up +2.9%, making an ALL-TIME higher-high at 873 (versus 865 in April of 2011)!

Both VOLUME and VOLATILITY signals finally confirmed the PRICE moves – and it was broad based, across sectors

In our multi-duration S&P Sector Model, all 9 sectors are bullish on all 3 of our core risk management durations (TRADE, TREND, and TAIL) for the first time since December of 2011. We call those Bullish Formations.

Yes, in spite of the Fed and Congress – global growth stabilized as expectations for future Fed Intervention came down huge (CFTC Futures and Options net long contracts dropped -49.5% from their all-time top in September to the December lows).

Now what?

Rather than using Grantham’s duration (his 0% growth forecasts extend out to the years 2030-2050 – yes, you can fire me if I ever try durations like that), let’s focus on where at least 90% of money managers have to focus on these days – the intermediate-term TREND.

Let’s start with where US GDP Growth is at – at least +2-3%, not 0 to 1%

You can get mad about how Obama is getting to +2-3% (spending), but you also have to understand it

Government spending is tracking +9.5% on an annualized basis – that’s a big pop

*Reminder: GDP = C + I + G + (EX-IM). So, given that Congress just yard-saled the can on spending cuts, the G (government spending), is not going to be a headwind for Q113 GDP either. It might be in Q2 or Q3 – we’ll let you know when we think we know.

And a lot can happen in between now and Q2. What if the employment report tomorrow starts getting consensus thinking about a 6% handle on the US unemployment rate?

Oh, no you didn’t Bernanke – you didn’t take your “experimentation” too far in targeting random numbers now did you? What if Bernanke is what he usually is – wrong on his growth forecasts? What if unemployment rate expectations start to fall towards 6.5% in 2013 instead of in 2017? Inquiring Bond and Gold bulls would like to know…

I have no idea what the unemployment rate is going to be tomorrow – but what I can tell you is that:

Weekly US Jobless Claims have been tracking well below our critical employment growth level of 385,000

Both Bonds and Gold have been signaling this shift in employment growth stabilizing for the last 3 weeks

Again, this doesn’t mean I am bullish on US growth forever. To the contrary, what I am really telling you is to really respect that Big Government Intervention perpetuating short-term economic cycles works both ways.

Growth scares work just as well on the upside as they do on the downside. And if the market is sniffing this one out right, wouldn’t it be ironic and deserving, all at once, for Ben Bernanke’s latest policy expectations gamble to pop the biggest bubble of them all – bonds.

Fund flows out of bonds and into stocks would come back to this market in a hurry. The US stock market perma-bulls have been waiting for that train since 2007. If #GrowthStabilizing holds, that loco market machine may have already left the station.

Shipbuilding Update: Walking Down a Long Plank

Takeaway:Order and Backlog data, along with signs of Chinese competitive entry in offshore, continue support the short side in SK shipbuilders.

Shipbuilding Update: Walking Down a Long Plank

Backlogs Sinking Fast: Consistent with long down-cycle in commercial shipbuilding, there has been no meaningful rebound in orders. That has left shipbuilders to drain backlogs, reporting revenues that relate to years-old demand. Backlogs have been on a steady downtrend, inflating revenues relative current demand. Chinese backlogs fell from 169.3 mil tons at the end of 2011 to 116.4 mil tons at the end of September.

Short Fuse: Samsung Heavy has only about two years of work left in backlog, while Hyundai Heavy has only about 1.5 years. When backlogs with high margin orders are gone, revenues and profits should reflect the more averse current market. Using multiples of income statement items produced by draining backlogs is not a reasonable valuation approach, in our view.

Pricing Highly Competitive: Global shipyards are desperate for new orders to keep their docks full (article). As backlogs continue to fall, pricing is likely to become irrational, in our view. Chinese competitors may be particularly aggressive. This will happen for a long time, if previous cycles are any guide.

About Offshore: It has been our contention that Chinese shipyards will become increasingly proficient in offshore energy production vessels, undermining the bullish thesis on South Korean shipbuilders. Since this cycle will take upwards of a decade, the Chinese have plenty of time to enter every relevant offshore market, in our view. Chinese entry has continued to be aggressive, as discussed in the WSJ yesterday here.

Performance & Opportunity: Since we first posted a note on the short opportunity in the Korean shipbuilders here, Samsung Heavy has only underperformed the KOSPI by ~ 8%. We think there is a good deal more that this short has to run as favorably priced orders in backlog are not replaced and margins contract toward historical (read: low) norms. We value Samsung Heavy at around krw 10000-14000 in our base-case DCF vs. a current market price of krw 37800 and we expect that gap to close over the next few years.

Additional Information: We have additional background on the Shipbuilding industry, so feel free to follow-up if this industry is of interest.

Jay Van Sciver, CFA

Managing Director

HEDGEYE RISK MANAGEMENT111 Whitney Avenue

New Haven, CT 06510

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Idea Alert: Shorting Macy's

Takeaway:We're capitalizing on our department store short theme by adding Macy's into our #Real Time Alerts. Valuation is not a catalyst.

We’re adding Macy’s to our #Real Time Alerts on the short side. The theme is similar to the call on KSS that we made yesterday, but with more operational and financial leverage. We’re also bearish in GPS for some similar reasons. We’d characterize expectations around both inventories and comps heading into 2013 as being way too complacent.

For 2013, we’ll be going against a year where JCP will have ceded nearly $4bn in share, and it starts to comp against that in a few short weeks. Will JCP comp positive? Not likely. But even if it comps down 5 or 10% that creates a meaningfully negative delta to the companies that benefitted from the displacement.

Furthermore, inventories industry-wide were extremely tight in 2012 despite JCP’s issues, thanks to the off-price channel keeping the channel clean. That buffer will be unlikely to carry the trajectory forward in 2013.

Out of every name in the space, the most emotion rests with Macy’s. We consistently get the argument stating ‘you can’t short it bc it’s cheap’. But when you look historically, valuation has almost never been a catalyst to buy department store names. We don’t think now is a time to start.

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01/16/13 03:56 PM EST

BEST IDEAS UPDATE: RE-SHORTING THE YEN HERE

Our proprietary quant signals are telling us now is a good time to re-short the Japanese yen, which we’ve done through the etf FXY. We’ve got levels for that security, the USD/JPY exchange rate and the Nikkei in the charts below.

Regarding Japanese equities specifically, shorting the yen here probably means some reflation across Japanese stocks – almost by default to some degree. Enjoy this trade while it lasts; like the many others before it, this latest Keynesian experiment won’t end well for the Japanese economy.

In addition to this update on Japanese risk, we take a step back and walk through our broader process in greater detail for those of you who may be interested. As always, we're around to dialogue further.

Earlier this morning, we got our quantitative signal to re-short the Japanese yen, our Macro team’s best idea on the short side with respect to the TREND and TAIL durations.

Since peaking intraday at ¥88.62 per USD on early Monday morning and €120.05 per EUR on Sunday night, Japan’s burning currency has corrected to another lower-high on the strength of concerned commentary out of Japanese officials and some degree of profit taking ahead of next week’s BOJ board meeting.

@Hedgeye, we always find it helpful to remind existing clients and educate new clients on our process, which is two-fold in nature:

Fundamental RESEARCH themes – longer term in nature (intermediate-term TREND and long-term TAIL)

FISCAL: The LDP wins a majority in the Upper House pending elections late-JUL/early-AUG, paving the way for a full-fledged assault on Japan’s public finances; and

FISCAL: A VAT hike delay (discussions to flare up in late 2013).

As it relates to the aforementioned commentary, both Economy Minister Akira Amari and Chief Cabinet Secretary Yoshihide Suga made public statements this week highlighting the expected adverse impact of “excessive” exchange rate depreciation upon the Japanese economy.

Personally, I think they were simply jawboning to reduce international criticism of their beggar-thy-neighbor monetary policies, as highlighted by recent comments out of Korean, Eurozone and Russian officials in the week-to-date. All this means to us is that the yen won’t go to ¥100 per USD next week…

As we pointed out on slide #52 in the aforementioned presentation, it truly is Japan’s turn to take center stage in the global Currency War.

As such, we see no need to alter to our structural bias on the yen in light of these explicitly hawkish comments. Prime Minster Abe and Finance Minster Aso are likely going to need to see a much lower exchange rate(s) if they are even going to even sniff their +3% nominal GROWTH and +2% INFLATION targets on a sustainable basis.

Regarding the upcoming BOJ board meeting, to some degree, their likely adoption of a +2% INFLATION target and incremental monetary easing was somewhat priced in Sunday night/Monday morning, prompting some investors to reduce positions. Moreover, the fact that Amari himself plans to attend the meeting may be quashing some hopes of anything truly meaningful on the easing front.

While this may be true to some degree, we continue to look well past next week’s meeting and to mid-FEB when Japanese policymakers plan to commence discussions on who will replace the upcoming three vacant seats atop the BOJ board.

All told, our proprietary quant signals are telling us now is a good time to re-short the Japanese yen, which we’ve done through the etf FXY. We’ve got levels for that security, the USD/JPY exchange rate and the Nikkei in the charts below. Regarding Japanese equities specifically, shorting the yen here probably means some reflation across Japanese stocks – almost by default to some degree.

Enjoy this trade while it lasts; like the many others before it, this latest Keynesian experiment won’t end well for the Japanese economy.

Darius Dale

Senior Analyst

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